Cryptocurrency: key considerations for insolvency practitioners

Cryptocurrency: key considerations for insolvency practitioners

Statement on the Legal Status of Cryptoassets and Smart Contracts

Cryptocurrency is a hot topic in the legal industry and one with which the legal world is really just starting to grapple. This is ever more prevalent with a number of recent high-profile crypto insolvencies including Three Arrows Capital, Celsius Network and FTX. Such market events have also reinforced the UK government’s commitment to introduce a new regulatory regime for cryptoassets, publishing its proposals on the future of UK’s regulatory regime for cryptoassets on 1 February 2023.

Cryptoassets, it would appear, are increasingly being used to hide wealth and therefore we expect to see them cropping up in the growing number of company failures (and personal bankruptcies) in the near future. Insolvency practitioners (IPs) need to be on the front foot quickly to identify and realise such cryptoassets; failure to do so could materially impact the return to creditors and expose an officeholder to a claim by creditors.

We set below are our "top tips" for officeholders when dealing with cryptoassets.

1. Identifying cryptocurrency

Cryptocurrency is usually stored in a "wallet" which, unlike its traditional meaning, is simply a string of private and public key addresses, although some may contain specific transaction or balance details. A "wallet" can be stored in several ways, including on desktops, specifically designed devices, paper, or even hosted by third parties.

Therefore, cryptoassets, or signs of them, can be found almost anywhere when examining the company’s or individual’s books and records. This could include correspondence, financial records (especially where transactions are linked to cryptocurrency exchanges, such as Binance and Coinbase), internet search history, a piece of paper or even a QR code. IPs should be mindful of any random strings of letters and numbers identified within the books or records (or miscellaneous QR codes) which may help to identify cryptoassets.

2. Recovering cryptocurrency

Once cryptocurrency has been identified, an officeholder will need to obtain the private key to be able to access and transact with it. In lieu of any company directors’ cooperation in providing this information, an officeholder will need to consider initiating court proceedings to obtain it.

Requests for any details relating to the private key could form the basis of an application under sections 234 or 236 of the Insolvency Act 1986 (the act) to summon relevant individuals to court. These types of application could take time however and, therefore, risk the cryptocurrency being dissipated in the meantime.

Once the officeholder has control of the cryptocurrency, consideration will need to given on how the cryptocurrency is secured, whether through a third-party custodian, exchange or simply by securing the wallet offline, thereby preventing unauthorised access. Where cryptocurrency is insured, the officeholder will also need to ensure that they have complied with any security requirements stipulated by the insurer.

3. Investigating transactions

Since the English courts have now taken the view that cryptocurrency is a form of property, any transfers of cryptoassets could constitute a transaction at an undervalue or transaction defrauding creditors under sections 238 and 423 (respectively) of the act. However, cryptocurrency transactions can be complex to trace, and specialist knowledge will likely be required. This can entail a significant cost and the officeholder will need carefully to balance the benefit of pursuing the action for the wider body of creditors.

Another complexity present in these types of transactions is that beneficiaries often remain anonymous and further investigations and applications to court could be required. In the context of cryptocurrency and fraud cases, this has generally been done through applications for injunctions against unknown individuals or information orders against cryptocurrency exchanges.

A practical solution for officeholders is available through section 236 of the act by requiring the relevant exchange or custodian to provide the necessary information to identify the beneficiary. Where a transaction at an undervalue is established, the court has discretion to order different forms of relief other than requiring the original property be restored. This could include accounting to the officeholder for the benefit received in fiat currency.

4. Valuing and distributing cryptocurrency

Since the cryptocurrency market is highly volatile, an officeholder will have a lot to consider when it comes to valuation and distribution. Such considerations include whether to convert the cryptocurrency to fiat currency, the timing of any intended sale and how any apportionment is to be dealt with.

Particularly where there is a significant amount of cryptocurrency, it will be important to take a view on whether it is all sold at once or in tranches. To minimise any potential criticism from creditors, an officeholder may wish to seek an order from the court for directions regarding any intended disposal.

Finally, the law relating to cryptocurrency and insolvency is fast evolving and the relevant issues to consider will often depend upon on the circumstances in each case.

For more information on cryptocurrency, please click here.

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